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I Was Wrong About Apple, Inc. Earnings

Well, don't I feel foolish (lowercase "f"). I fully expected Apple (NASDAQ: AAPL) to report a disappointing quarter, both because it seemed possible that guidance for the September quarter could have been issued before Apple was aware of iPhone X production delays, and a constant string of reports from supply chain sources and Street analysts suggested the production problems were rather severe.

It turns out that neither of those were the case: Apple just reported a record September quarter and guided the December quarter to uncharted territory.

Image source: Apple.

The headliners

Revenue in the fiscal fourth quarter jumped 12% to $52.6 billion, beating even the high end of Apple's guidance that called for $52 billion in sales. That translated into net income of $10.7 billion by the time it reached the bottom line, or $2.07 per share. Apple sold 46.7 million iPhones, 10.3 million iPads, and 5.4 million Macs.

iPhone average selling prices (ASPs) increased modestly on a sequential basis, from $606 in the June quarter to $618 in the September quarter as models at both ends of the pricing spectrum continue to sell well. On the conference call, CEO Tim Cook said the iPhone X ramp is "going well," especially considering that it's the most advanced iPhone Apple has ever made.

Image source: Apple.

The Mac enjoyed significant share gains, with unit sales jumping 10% while the broader PC market contracted by 0.5%, according to IDC. The MacBook Pro refresh over the summer is driving sales.

Greater China returns to growth

Over the past couple of years, Apple's Greater China has been relatively weak, with a string of quarterly declines. That ended this quarter, with Greater China revenue returning to growth. Sales rose 12% to $9.8 billion.

Data source: SEC filings. Chart by author. Calendar quarters shown.

Cook said the strength was broad-based across all products, while services revenue hit a new record in China. Both upgraders and Android switchers in China were up year over year, too. The troubles Apple has been facing in Hong Kong also moderated, and Cook acknowledged that the recent quarters of weakness paved the way for an easier comparison this time around.

Services marches toward its ambitious goal

Earlier this year, Apple publicly set a goal of doubling its services business by 2020, relative to fiscal 2016 levels. More specifically, the goal is to hit $50 billion by 2020.

Services revenue in the September quarter grew 34% to $8.5 billion, a new record. However, that includes a one-time positive adjustment of $640 million. If you back out this adjustment, services revenue still grew 24%. Services revenue in fiscal 2017 was $30 billion, up from $24.3 billion in fiscal 2016, so Apple is making meaningful progress toward its target.

Data source: SEC filings. Chart by author. Calendar quarters shown.

The drivers of the services business are the same three usual suspects: the App Store, Apple Music, and iCloud. The App Store hit a new record, thanks to both a growing number of active accounts and increased transactions and spending among existing accounts. Apple now has over 210 million total paid subscriptions across its platforms, up from 185 million last quarter.

Management said Apple Music subscriptions are up 70% without specifying a figure, but Apple Music chief Jimmy Iovine told Billboard at the end of September (around the same time that this fiscal quarter closed) that the service now has 30 million paid subscribers.

Cash and capital returns

There was nothing notable about Apple's capital return activities in the September quarter. The Mac maker returned $11 billion of capital to shareholders during the quarter, including $3.3 billion in dividends and equivalents, $200 million in net share settlement, and $7.5 billion in share repurchases.

Of those buybacks, $4.5 billion were bought back in the open market, and Apple entered into a $3 billion accelerated share repurchase (ASR) program. To date, Apple has bought back a mind-boggling $166 billion in stock since fiscal 2013.

Total cash was $268.9 billion at the end of the quarter, of which $252 billion was sitting overseas. The company issued roughly $7 billion in term debt during the quarter, bringing total term debt to $103.7 billion. In other words, net cash is at $165.2 billion (flat sequentially).

Surprise!

Guidance was always going to be the most important part of the release, as the most direct insight into the iPhone X production situation. If the bottlenecks were as severe as media reports portrayed, it would show up clear as day in Apple's financial forecast in the form of depressed sales outlook. In no uncertain terms, Apple's outlook blew it out of the park: Revenue is expected in the range of $84 billion to $87 billion, simultaneously topping the consensus estimate among analysts and assuaging fears surrounding iPhone X production.

Data source: SEC filings. Chart by author. Calendar quarters shown.

Gross margin in the December quarter should be in the range of 38% to 38.5%, with operating expenses of $7.65 billion to $7.75 billion. Other income and expense should be about $600 million, and Apple is expecting a tax rate of 25.5%. Using the midpoints of all of those ranges, the forecast implies net income of over $18.1 billion in the December quarter.

I've never been so pleasantly surprised to be so wrong.

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Evan Niu, CFA, owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.